Con­sol­i­da­tion may Not be a Panacea for Banks’ Woes

The as­set qual­ity of In­dian banks de­te­ri­o­rated sig­nif­i­cantly over the last three years, with gross non-per­form­ing ad­vances (GNPAs) in­creas­ing to 9.5% as on March 31, 2017 from 3.6% as on March 31, 2014. This de­te­ri­o­ra­tion was sharper in public sec­tor banks (PSBs) com­pared to pri­vate sec­tor banks (PVBs), given the for­mer’s rel­a­tively high ex­po­sure to in­fra­struc­ture and steel sec­tors. While GNPAs of PSBs in­creased to 11.4% as on March 31, 2017 from 4.4% as on March 31, 2014, that of PVBs in­creased to 4.2% from 1.8% dur­ing the same pe­riod. As a con­se­quence, PSBs prof­itabil­ity got im­pacted as they are re­quired to do higher credit pro­vi­sion­ing against these NPAs; their cu­mu­la­tive losses were ₹ 24,200 crore dur­ing FY16 and FY17 as against cu­mu­la­tive profits of ₹ 61,700 crore dur­ing FY14 and FY15. This also ac­cen­tu­ated their need for rais­ing fresh cap­i­tal, a re­quire­ment that had al­ready in­creased un­der the Re­serve Bank of In­dia’s (RBI’s) Basel III reg­u­la­tions. Fol­low­ing the ero­sion in PSBs’ earn­ings and cap­i­tal po­si­tion, do­mes­tic rat­ing agen­cies have down­graded the credit rat­ings of 13 out of the ex­ist­ing 21 PSBs over the past three years. On the other hand, rat­ings for PVB bor­row­ings have largely re­mained sta­ble with some in­stances of up­grades as well. To­day, only three PSBs have debt rat­ings at AAA as against six as on March 31, 2014, whereas only three PSBs are now rated AA+ as against eight as on March 31, 2014.

The as­set qual­ity pain for the bank­ing sec­tor will con­tinue dur­ing FY18 as large quan­tum of vul­ner­a­ble ad­vances un­der­go­ing res­o­lu­tion through var­i­ous scheme of stressed as­sets, may slip in FY18. In ad­di­tion, NPAs in agri­cul­tural sec­tor have in­creased post an­nounce­ments of farm loan waivers. Thus over­all GNPAs are ex­pected to in­crease to 10.1-10.2% by March 31, 2018 (PSBs to 12.2-12.3% and PVBs to 4.54.8%). More­over, with the RBI di­rect­ing banks to in­crease credit pro­vi­sions for ac­counts, where pro­ceed­ings have been ini­ti­ated un­der the In­sol­vency and Bank­ruptcy code (IBC), by March 31, 2018, PSBs’ prof­itabil­ity will re­main un­der pres­sure dur­ing FY18 as well and pos­si­bly there may be losses for a third con­sec­u­tive year too.

The scene be­comes worse with the PSBs need­ing an in­cre­men­tal eq­uity cap­i­tal of ₹ 90,000-1,00,000 crore and tier-I (AT-1) cap­i­tal of ₹ 20,000-40,000 crore dur­ing FY18 and FY19, re­spec­tively, to meet the reg­u­la­tory norms for cap­i­tal. The Gov­ern­ment of In­dia’s bud­geted pro­vi­sion of ₹ 20,000 crore of cap­i­tal in­fu­sion falls short and; also the wind­fall trea­sury gains of FY17, or the cap­i­tal re­lief from reval­u­a­tion of fixed as­sets of FY16 are un­likely to re­cur in the near term. Hence, many PSBs will strug­gle to meet reg­u­la­tory cap­i­tal re­quire­ments un­less they raise cap­i­tal from the mar­kets.

The weak prof­itabil­ity and cap­i­tal po­si­tion are also re­flected in the out­look on debt rat­ings—19 out of 21 PSBs cur­rently have a “neg­a­tive” out­look on their rat­ings from at least one of the credit rat­ing agen­cies with like­li­hood of fur­ther down­grades over the next year. Only State Bank of In­dia and In­dian Bank have sta­ble out­looks from all rat­ings agen­cies. Weak prof­itabil­ity im­plies banks’ AT-1 bonds (which can be ser­viced only through profits or ac­cu­mu­lated profits) will see higher tran­si­tion than the Tier II in­stru­ments of these banks.

In this back­drop, the suc­cess of pro­posed GOI’s ef­forts to­wards banks con­sol­i­da­tion re­mains to be seen. At a time where many PSBs are grap­pling with chal­lenges of as­set qual­ity, cap­i­tal and prof­itabil­ity, con­sol­i­da­tion ex­er­cise alone may not suf­fice. While con­sol­i­da­tion en­hances the size, it is not a panacea for woes. Past ex­pe­ri­ence shows that merg­ers come along with a num­ber of in­te­gra­tion is­sues, which de­mand man­age­ment at­ten­tion and this may re­duce their band­width from the on­go­ing NPA res­o­lu­tion process.

A merger of two weak banks does not lead to one strong bank in the near term. On the con­trary, a weak bank merged with a sim­i­lar-sized strong bank may weaken con­sol­i­dated credit pro­file. The pro­posed PSBs con­sol­i­da­tion would thus be a ma­te­rial event, mon­i­tored closely.